Silver Lining Playbook: Deductions for Net Operating Losses

Silver Lining Playbook: Deductions for Net Operating Losses

Even a wildly successful business doesn’t show continuous profits throughout its lifetime. Some amount of loss is almost inevitable, but a business loss can have a silver lining when it comes to the Internal Revenue Service. Deductions for a business loss can provide tax relief and give you a significant refund – possibly as much as your entire previous year’s tax payment.

Sole proprietorships can choose to deduct losses from other income, such as investments, wages and spousal income on joint returns. Your filing status becomes somewhat more complex when you are part of an LLC, partnership or S corporation, but your individual return still carries your share of the total business loss that passes through the company to you. Only C corporations cannot make business loss deductions on individual returns; in these cases, the loss is ascribed to the business and should be handled by a CPA with corporate tax experience.

You can earn deductions for any business loss, but if you have a net operating loss, or NOL – defined as a loss that is greater than your total annual income from all sources – you may be eligible for greater tax relief in a shorter time. Not only can you receive a refund, you may also be able to apply your NOL deduction in future tax periods.

Calculating Net Operating Losses

While the concept of the NOL is straightforward, calculating it is not. Subtracting one figure from another and arriving at a negative number is only the first step. After you and your accountant have assessed your total annual loss from your business, compare it to your total business income for that year according to IRS Schedule C. For businesses in which you are a partner or S corporation shareholder, you incur a share of that NOL as determined by your share of the company’s income for the year in question. Your loss, along with your other personal deductions, must be added together and taken away from your reported income to arrive at your Adjusted Gross Income, or AGI.

You only have a net operating loss if your AGI is smaller than your itemized or standard deductions without your personal tax exemption. After arriving at this figure, include non-business deductions that exceed your income from non-business sources. This is where your standard individual deduction, capital losses, charitable donations and IRA contributions are calculated. If you arrive at a negative number after subtracting that figure, you have an NOL and qualify for deductions or can carry back the loss.

Carrying a Loss Back or Forward

An NOL could qualify you for a refund within 90 days if you file an application for a refund or apply for an amended return, a process known as carrying back. The money you receive comes from the amount you previously paid, allowing you to recoup business losses quickly. Note, though, that if you paid no significant income tax previously, you may not gain much from your NOL deduction. You may also decide to wait on claiming it if you expect a substantial increase in your income over the next few years when it could offset a higher tax rate.

Under some circumstances, you can carry back your NOL for more than the usual two years. If you were subject to casualty or theft, you can carry your deduction back three years. Businesses in declared federal disaster areas, such as parts of the Northeast after Hurricane Sandy or the Gulf Coast after Hurricane Katrina, may also opt to carry back three years. For agricultural businesses and farms, the NOL period is five years to accommodate the drastic effects that weather conditions have on these businesses.

A similar option lets you carry a loss forward and apply it to future years’ tax returns. Your NOL can carry forward far longer than it can be carried back; you can elect to carry your deduction forward for as much as 20 years. Like carrying back, the option to carry forward allows you to recoup past losses in the future when they are most needed.

Claiming Business Losses and Filing Tax Returns

To claim a business loss, you or your accountant will need to file a fair amount of paperwork. The IRS Form 1040-X, Amended U.S. Individual Income Tax Return lets you file within three years of your NOL, but the process could take some time to move through the system. The IRS Form 1045, Application for Tentative Refund, if approved, requires the IRS to send your NOL refund within 90 days.

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